This is a follow-up to my last post on the prevailing trends in e-commerce, I touched on marketplace e-commerce business models only briefly because it is a complex topic that require its own post.

We, at MuckerLab, love businesses not possible before the “invention” of a particular medium or platform – not only because (superficially) it’s a green field opportunity but also because these businesses are unencumbered by legacy constraints that had previously been hardwired into companies and industries these startups are trying to disrupt.  “Online marketplace” is one example –   an entirely new business model not possible (at scale) before the internet.  For a while during the first dot-com era, marketplaces were all the rage – with eBay leading the charge and dominating B2C – venture capitalists and entrepreneurs stamped out B2B marketplaces in every single vertical possible. By the end of the dot-com era, 99% of the b2b marketplaces cratered and eBay was left standing and thriving.  The prevailing consensus was that B2B marketplaces were too hard (e.g. workflow, not liquidity driven) and that B2C marketplaces cannot be built under the giant momentum of eBay’s “network effect.”  Investment stopped and entrepreneurs focused on other categories.  Turns out, network effects can be broken (e.g. Amazon and StubHub taking on eBay in mid 2000’s and the multiple second hand fashion marketplace startups today) and that there are tons of untapped verticals (e.g. Airbnb, oDesk). Plus if we just rebrand marketplaces, “collaborative consumption”, VC’s will open up their wallets (j/k).

As e-commerce becomes an investment thesis again, there are still a significant portion of VC’s that will not invest in traditional e-tail driven business models. They believe e-tail does not benefit from increasing return to scale or barrier to entry because of the lack of network effects. As a result, in many e-commerce verticals, the only way to get venture funding is to build a marketplace rather than build a e-commerce store front. (In most services driven verticals, marketplace is probably the only path possible.) However, one of the major problems for many “network effects” driven businesses is the “empty chat room” conundrum. Like a chemical reaction, a certain amount of activation energy (in marketplace talk, liquidity) needs to exist in the value network in order for the virtuous adoption cycle to take place. How do you achieve that critical mass of users needed in order to attract more users and eventually create barriers to entry to dominate your market? There are several strategies employed by marketplaces – most are not mutually exclusive.

1. Start with aggregating scarce and in-demand inventory.In markets where demand outstrip supply – collectibles, antiques, vintage luxury products – the two sided marketplace problem can usually be solved by focusing on the supply side part of the business first.  Typically, demand and buyers can be found after supply liquidity has been achieved through a combination of word of mouth and SEO. eBay did a great job by building its initial marketplace around the collectibles category before expanding further. (see next point)
2. Build “localized” network value.  It is critical for marketplaces to focus on creating critical mass in one specific segment of the customer base via marketing and sales. Users place different network value on having different type of users in the same marketplace based on their own preferences. Find a segment of the target market that values each other disproportionately higher than any other segments and concentrate on building critical mass in that segment before moving on to the next. (Really an extension of Crossing the Chasm for network effects businesses.)  Again, take eBay as an example, the Beanie Babies crazy in the mid to late nineties essentially jump started eBay.
3. Siphon off demand and/or supply from another destination.  For a long time, this strategy remained the playbook of the paypal mafia (paypal used a variation of this strategy to build itself within and under the nose of eBay). More recently, given the preponderance of startups trying to do the same to/on Craigslist – starting with Airbnb, the question is no longer “if” but “where” to go to siphon off demand or supply. In reverse, the smart companies with critical mass of users have realized that “traffic” (which begets supply and demand) is the ultimate currency on the Internet thus they can become platforms by enabling structured methods (often as APIs) to allow smaller startups to syphon off inventory or users in exchange for revenue, ad inventory, branding or even more traffic. (Google, Facebook, eBay etc). More recently Pinterest, Intagram has also become destinations where startups are hacking for users, traffic, inventory and demand.
4. Leverage influencers for liquidity. One of the most important trends in how traffic is distributed on the Internet is that individual are increasingly able to manipulate and control how their personal network value is directed versus the platform in which she built her network. (twitter vs. twitter users). The outcome for startups building marketplaces is that even in closed platforms, they can recruit influencers who already have built a sizable personal network effect to help sell, purchase, market, and source inventory for their destination.
5. Create “point” product value. This strategy is probably the least understood and under-utilized in consumer driven marketplaces. In essence the strategy is to design marketplaces that have 2 components to its value proposition – point and network value. The point value is value proposition for the product independent of the # of people in the network. Point value is SAAS-like in nature – it allow users be more efficient, more accurate, and more productive.  As a result, users are compelled to adopt the solution regardless of marketplace liquidity. The harder part is to create coherent synergies between the two components that encourage the usage of the network component once the user begins using the point value feature set.
6. Support series of one-to-many relationships. Using a related tactic to 4 and 5, one way to build marketplaces is to not treat the initial objective as building a marketplace but as enabling a series of connected but individual store fronts.  Start by allowing a single major buyer (more prevalent in B2B use cases) to more efficiently purchase from its existing supplier base, or in reverse (more common in B2C) enable a single seller to sell to its existing or new customers. The latter case, which is more applicable to e-commerce, the objective is to have a seller treat the personalized store as his or her own online presence and actively market it in existing marketing channels (social media, business directories, brochures, TV etc). This strategy is especially effective in taking offline merchants online as they lack sophisticated technology capabilities and will view the solution as an e-tail platform first and foremost and as a marketplace second. Furthermore, offline merchants already have captive customer bases to bring online – thus increasing marketplace velocity. Once multiple one-to-many networks are stood up, incremental tweaks to the inventory discovery experience can quickly turn the site into a full blown marketplace.
7. Backfill with non-transactional listing to augment liquidity.  In most marketplaces, demand is non-persistent and perishable, i.e. most people do not need to buy 20 of the same beanie baby continuously for the next 3 month. As a result, demand needs to be continuously generated. Supply, however, is a different animal. Some supply is perishable such as one-of-a kind collectible baseball card, once someone buys the card; it is no longer available for sale.  Some supply is more persistent than others, such as plumbing services or commodity goods. Holding everything else constant, it is much easier to create liquidity in marketplaces where supply is persistent. Airbnb actually enjoys this phenomenon where it only has to acquire the “seller” once and his or her room or house will be available for rent on Airbnb for a persistent period of time (when it’s not rented out). In these categories, non-transactional (online or offline) directory or classified aggregators often exist such as Yellowpages for plumbers or Craigslist for temporary room for rent. It is often possible to backfill a marketplace with non-transactional listings to give buyers some limited value while the true liquidity is still being built.
8. Time Shift Demand and Supply. Many of the current mobile focused marketplaces do a good job in time shifting demand or supply so that they can artificially be matched. Based on preferences or expressed user behaviors, these apps would send sms or app notifications when either a product becomes available for sell or conduct flash auction events for particular product category to pull supply and demand closer together.   Back in the days, we used to use a technique called “manually making a market,” i.e. like good commodity trader, we take a “buy order” and we shop it proactively across the market even if there isn’t a matching “sell order” to find latent demand or supply. In the early days of a marketplace, don’t rely on the user to “find it” on your marketplace – use any channel or  means possible to generate liquidity – if that means picking up the phone – so be it.

The probability of success for a new venture is by definition very low. Entrepreneurs looking to launch marketplaces must understand that the probability of success for marketplaces is not just linearly harder than traditional e-tail models but magnitudes harder.  On the other hand, once having achieved liquidity, marketplaces have significant advantages to simple e-tail businesses: merchandizing is organic, supplies self-adjusts to demand, growth rates are typically exponential, barrier to entry are much higher, and of course margins are 3X-4X higher as well.  There is always a leap of faith and an element of luck when it comes to building successful marketplace businesses.  By methodically stitching together a set of strategies and tactics to build liquidity, it is possible to reduce that element of luck and increase the probability of success.  In the end, success is not entirely impossible or uncontrollable. Especially given the outsized returns for winners, entrepreneurs looking to build billion dollar companies, must seriously consider attacking a market opportunity with the marketplace business model despite all the initial hurdles.